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The Cyclical Bull Resumes

(August 22, 2004)

Please note that our DJIA timing system initiated a 100% long position in the Dow Industrials at 10,022 on Thursday afternoon.  At the time of the publication of this commentary, we are up a total of 88 points.  We will be updating our website in the month or so in order to establish a section for our DJIA timing system.  Again, please continue to forward this commentary to anyone who you think may be interested in our services.  We still need all the subscribers that we can get.  Our discussion forum is now also online.  Please post all your questions about the market and individual stocks in our discussion forum from now on - this will also encourage more discussion and will also help other subscribers and readers in their analyses of the stock market.  Registration is free.

Dear Subscribers and Readers:

At this point last week, the market was staring down at the edge of the abyss - the end of the decline looked near, but since huge market declines often come near the end of a correction (and because of the fact that corrections during cyclical bull markets tend to be short-lived but very sharp), a Dow Industrials print of 9,500 seemed to be a very distinct possibility.  In retrospect, we now know that the bull came through, and we also now know that the public who sold their mutual funds during the last couple of weeks are now itching to get back in (possibly waiting for another correction to get in - a correction that may never come).

The short-term resistance levels on the DJIA and DJTA are now 10,179 and 3,134 respectively, as represented by the most recent peak in those respective indices.  My guess is that these resistance levels are now meaningless, as I do not believe this cyclical bull market is close to topping out yet.  The following chart of the DJIA vs. DJTA puts last week's rally into perspective for the pure technical analysts, but as illustrated later in this commentary, I believe this rally is a sustainable rally and because of this, we will ultimately see new highs in these two indices:

Daily Closes of the Dow Jones Industrials vs. the Dow Jones Transports (January 1, 2003 to August 20, 2004) - The Dow Industrials and the Transports managed to rally out of the abyss in the latest week, as the former rallied 284 points while the later rallies 124 points during the week. For the first time in approximately six months, this latest rally actually looks sustainable.

To begin my analysis, I would like to dispel a notion that various analysts have spoken about in the last couple of weeks or so - that we are now in the seasonally "bad times" of the year and because of this, it may be a better idea to buy during October, when the major market indices have tended to experience a seasonally bottom.  Dear readers, I have already discussed the validity of this argument in my commentary a few weeks ago.  First of all, I would like to mention that corrections during the August to October period have usually been preceded by a rise in the indices at least during the previous January to April period if not the January to August period.  These corrections usually emerge because of a substantial rise in the market during the earlier parts of the year.  The stock market action of the last six months was weak and therefore, it is irresponsible to tell investors to stay out of the market because of "seasonal factors" when the stock market action over the last six months had already not followed historical seasonal trends.  Second of all, I would like to REPOST the following chart courtesy of  This chart provides a great illustration of "seasonal trends" during a typical election year - the analysts who are telling people to stay out of the market until October should study stock market history - my guess is that people who are on the sidelines and who are going to wait until October to buy stocks would be sorely disappointed over the upcoming months:

Average Election Year (Dow) -  The stock market has had a tendency of being somewhat choppy during the first five months of an election year, but prospects tended to improve(on average) as the Novemeber election approached.

Moving on: In last week's commentary, I promised my readers that I will give an update on the various liquidity indicators.  I will now do just that - and I will also argue that based on this various indicators (and others that I have mentioned or that I will mention) we are now in the midst of a sustainable uptrend.

I will first discuss insider sales.  It is interesting to note that despite the end of the earnings announcement season, insider sales during August have remained subdued.  This contrasts greatly with the February period and even the May period - when insider sales during that time were $2.2 billion higher than it is during August month-to-date (at the current rate, insider sales in May would ultimately be $1 billion less than August).  Insider sales have traditionally led stock market action - if this historical trend holds true, then the stock market should rise at least during the next few weeks:

Insider Sell-to-Buy Ratio vs. Month-End Close of S&P500 (December 2002 to August 2004) - Despite the end of earnings season, the insider sell-to-buy ratio has stayed relatively low. Total insider sales during August is also currently $2.2 billion less than the May 2004 number.

It is also interesting to note that the late August to September period is traditionally a slow time for initial and secondary offerings.  Because of this and the fact that insider sales are still low, the supply of stock over the next few to six weeks should remain subdued.  Finally, the relatively good success of the Google IPO earlier this week - despite the huge negativity created by the popular media on the IPO - is another bullish sign.

As readers may remember, I discussed the bullishness as exhibited by the margin debt numbers and the total credit numbers in cash and margin accounts in my July 26, 2004 commentary.  At that point in time, I did not possess July numbers - using my own projections instead in order to illustrate my bullish position.  Readers may like the fact that the July numbers were finally released last week.  More importantly, these final numbers pretty much confirmed the numbers I had.  At that time, I stated: "The author then attempted to project the numbers to what they are estimated to be today - the closing level on Friday was used for the Wilshire 5000 while the month-end cash and margin debt data was estimated given the recent performance of the stock market.  The author believes that margin debt may have dropped slightly (about a billion dollars) while the amount of free credit should at least experience the same increase as in June - that is, about $4 billion or so.  If that is indeed true (and there is a high probably then it is, or even better), then the total cash to Wilshire 5000 ratio should be the most bullish since the end of March 2003, while the cash in margin accounts and cash in all accounts to margin debt ratios should be at their most bullish since the end of April 2003."

The current July numbers revealed that margin debt dropped about $3 billion while total free credit rose by $3 billion - just $1 billion shy than the $4 billion that I had projected.  This confirms my bullishness based on my projected numbers three weeks ago.  In fact, the latest data revealed that the cash in margin accounts to margin debt ratio is now at its most bullish since the end of March 2003, not April 2003.  Following is the relevant chart with the July updates:

Wilshire 5000 vs. Cash and Margin Debt Ratios (January 1997 to July 2004)

My guess is that these numbers were even more bullish when the market bottomed earlier this month.  This chart shows the definite possibility of a sustainable uptrend.  While this uptrend may not be as broad or as explosive as last year's uptrend from the March 2003 lows, I would not be surprised if the Dow Industrials rose another 1,000 points in the next four to six months.  In fact, the author believes that when this cyclical bull market ultimately tops, we should be topping at a level somewhere north of DJIA 11,000.

While I have not mentioned short interest on the NYSE or the NASDAQ in awhile, I believe it is an important piece of the puzzle.  The latest NYSE short interest data (NASDAQ short interest data won't be released until later this week) shows that total short interest rose by approximately 135 million shares during the month ending August 13, 2004.  While this may not be bullish during a bear market, it is definitely a bullish sign during a cyclical bull market.  To a certain extent, this increase in short interest represents the creation of artificial supply - a supply of stock which will be covered at some point.  The total NYSE short interest is now at a high not seen since 14 months ago:

NYSE Short Interest vs. Dow Jones Industrials (November 15, 2000 to August 13, 2004) - For the month ending August 13, 2004, total short interest on the NYSE rose by approximately 125 million shares - short interest on the NYSE is now at a high not seen since June 13, 2003.

The NASDAQ short interest number is even more revealing.  As of July 15, 2004, the total short interest on the NASDAQ is only 60 million shares shy of a new all-time high (which was set June 15, 2004).  The August numbers will be published later this week.  Given the action over the last few weeks, my guess is that the total short interest on the NASDAQ rose to an all-time high in August:

Nasdaq Short Interest vs. Value of NASDAQ (September 15, 1999 to July 15, 2004) - As of July 15, 2004, short interest on the NASDAQ totaled 5.11 billion shares, just 60 million shares off its all-time high. The author's guess is that the August number rose to another all-time high.

I believe that the high short interest on both the NYSE and the NASDAQ represents another piece of the bull puzzle - this increase in short interest represents another bullish pillar given that we are still currently in a cyclical bull market.  The creation of all this artificial supply of shares should serve as a base for a sustainable uptrend in the major stock market indices at least during the next few months.

As I have mentioned before, another indicator that should serve as further evidence that a sustainable bottom has been made (and that a sustainable uptrend is at hand) is stock market sentiment.  One of the most popular gauges is the Investors Intelligence Survey conducted at the close each Wednesday and published the following morning.  In my commentary two weeks ago, I stated: "The Bulls-Bears% differential reading (the percentage of bulls minus the percentage of bears) in the Investors' Intelligence Survey is currently 24% -- slightly above the bottoming readings of 21 to 22% during March earlier this year.  Note that during the May 2004 bottom, this reading was only at 15%.  At the bottom of the cyclical bull market correction in November 1971 (the DJIA would rally by approximately 30% within the next 14 months), this reading was actually at 0% -- with the percentage of bulls equaling the percentage of bears at 37% apiece!  Therefore, this author would like to see another downside spike in this reading before I am comfortable in calling for a sustainable bottom."  This author got his wish last Thursday, as the Bulls-Bears% differential reading came in at 14.9%, slightly below the 15.1% reading confirmed on May 28, 2004.  The Bulls-Bears% differential reading in the Investors Intelligence Survey is now at its lowest since April 25, 2003:

DJIA vs. Bulls-Bears% Differential in the Investors' Intelligence Survey (January 2003 to Present) - During the last week, the Bulls-Bears% Differential in the Investors' Intelligence Survey not only broke its March lows, but it also broke below a 52-week low established on May 28, 2004. The Bulls-Bears% Differential in the Investors' Intelligence Survey is now at its lowest level since April 25, 2003.

Please keep in mind that this survey was done as of Wednesday evening - subsequent to a three-day rally of approximately 200 points in the Dow Jones Industrials!  From a contrarian standpoint, this is also very bullish.  Another good sentiment indicator is consumer confidence data as released by the Conference Board, due to be released this Friday morning.   A low consumer confidence number would serve as a confirmation of the low (and bullish) Bulls-Bears % Differential reading in the Investors Intelligence Survey.  Readers please stay tuned.

In last week's commentary, I discussed the topic of rising crude oil prices and its negative impact on the stock market.  The fact that the market has been generally rising during the latest week despite higher oil prices is a bullish sign.  However, it is to be said here that ultimately, oil prices will have to decline in order for the market to enjoy a sustainable uptrend.  Based on the analysis that I conducted last week, I believe that oil prices will decline very soon, if it hasn't already.  The trading on Friday showed signs of a reversal top.  Readers should also note that the front-month contract for crude oil officially switches to the October 2004 contract starting in tomorrow's trading.  As of the close on Friday afternoon, the October 2004 contract closed at $46.72, a full dollar less than the September 2004 contract.  For anyone that has been monitoring gasoline and natural gas prices as well, it is interesting to note that recent prices in these two commodities have not confirmed the rise in crude oil prices.  The following chart published by the Bank Credit Analyst last Friday morning illustrates this perfectly:

WTI Crude Oil Price vs. Gasoline and Natural Gas Prices - The prices in both gasoline and natural gas are still well below their recent peaks - thus not confirming this new peak in crude prices.

Once again, the disparity as exhibited by gasoline and natural gas prices (and reasonable inventory levels as I mentioned last week) calls for a significant correction in crude oil prices sooner rather than later.  Please keep in mind that while I am longer-term bullish on oil prices, the current supply and demand situation in oil just does not support a current oil price (basis the October 2004 contract) of over $46 a barrel.

Bottom line: The author still stands by the fact that we are in a cyclical bull market.  The author also believes that the cyclical bull market has resumed its uptrend - and that the uptrend is sustainable.  As of the close on August 17th, Lowry's Reports issued a ST buy signal - stating that the probability of a sustainable uptrend is now the highest in six months.  Moreover, TrimTabs, utilizing the concept of supply and demand of U.S. equities, has just turned fully bullish - establishing a 100% long position in the S&P 500 and in the Nasdaq 100.  While the market is overbought on a short-term basis, the probability now favors a significantly higher market three to four months from now.

Signing off,

Henry K. To, CFA

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